CPF (2019 - Q2)

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Central Pacific Financial Corp. Second Quarter 2019 Conference Call and Webcast. [Operator Instructions]. This call is being recorded and will be available for replay shortly after its completion on the company's website at www.centralpacificbank.com.I would like to turn the call over to Mr. David Morimoto, Executive Vice President, Chief Financial Officer. Please go ahead, sir. David Mo

Thank you, Chuck. And thank you all for joining us as we review the financial results of the second quarter of 2019 for Central Pacific Financial Corp. With me this morning are Paul Yonamine, Chairman and Chief Executive Officer; Catherine Ngo, President and Chief Executive Officer of our bank subsidiary; and Anna Hu, Executive Vice President and Chief Credit Officer.During the course of today's call, management may make forward-looking statements. While we believe these statements are based on reasonable assumptions, they involve risks that may cause actual results to differ materially from those projected. For a complete discussion of the risks related to forward-looking statements, please refer to our recent filings with the SEC.And now I'll turn the call over to Paul.

Thank you, David, and good morning, everyone. Over the past eight years, CPF has consistently improved its profitability, performance metrics and shareholder value. Nine months ago, the Board appointed me as CEO to take CPF to the next level of performance. I spent the last six months with Catherine and the rest of the executive management team developing a multifaceted initiative to take us to the next level. Today, I would like to introduce this initiative that we have named RISE2020.RISE2020 will build upon the foundation that has led to our recent success. We view it as an enhancement to our current strategy and not a change in strategy. We plan to further emphasize our strength and invest for the future in areas of opportunity. RISE2020 includes numerous initiatives, and I'd like to highlight four key areas of opportunity today: Digital banking; revenue enhancement; branch transformation; and operational excellence.In the area of the digital banking, CPF plans to implement best-in-class online and mobile banking platforms by the fourth quarter of 2020. We are currently developing new platforms that will replace our existing systems. Additionally, we are working to redesign our website and implement robust digital marketing capabilities. Revenue enhancements include the recent introduction of best-in-class small business products, including our Business Online Banking and Business Exceptional accounts. We also recently launched iBusiness Central and an enhanced suite of cash management products. Additionally, we plan to invest and emphasize our business development initiatives in Japan, where we have a sustainable competitive advantage.In the area of branch transformation, CPF plans to revitalize Central Pacific Plaza, the building we own in the heart of downtown Honolulu. The redesign will include co-working areas for small business customers and community meeting space for local nonprofits. Additionally, we will transform our flagship main branch to include innovative digital banking technologies to ensure an elevated customer experience. Our plans here will also include the installation of full-function ATMs. We will upgrade our other branch facilities following our main branch.Finally, in the area of operational excellence, we are implementing an end-to-end commercial loan origination system, and we are outsourcing residential mortgage loans servicing. Additionally, we are driving efficiencies in our customer-impacting areas through the expanded use of technology.In the aggregate, CPF expects to invest roughly $40 million on RISE2020 initiative. Some of these investments will be capitalized, while others are recurring annually. We expect annual operating expense to increase by roughly $7 million when RISE is fully implemented by the start of 2021. We have started to execute on some of the RISE initiatives, and it is generating a lot of excitement within the bank.We incurred approximately $1 million of RISE-related expense in the second quarter of 2019 and expect RISE-related expense to total roughly $2.5 million over the second half of 2019. While expense is increasing, we also are forecasting enhanced revenue growth. As a result, we expect our efficiency ratio to be in the 63% to 65% range in 2019 and 2020.RISE2020 will take CPF to the next level of performance with regard to customer and employee experience and also drive enhanced shareholder returns. We are targeting a 15% return on shareholders' equity and a 57% efficiency ratio by the end of 2022. We will provide more details on RISE2020 over the coming quarters.And now Catherine will provide highlights of our second quarter results. Catherine?

Thank you, Paul. I'm pleased to report that we realized solid growth in the second quarter of this year. While net income was impacted by the RISE2020 project and other investments for future growth, our balance sheet continued to expand in our targeted areas with strong gains in loans and core deposits. Total loans increased by $146 million or 3.5% over the previous quarter and by $366 million or 9.4% year-over-year. Loan growth was strong across all loan categories on sequential quarter basis, led by increases of $65 million in resi mortgages, $35 million in commercial mortgages and $24 million in commercial and industrial loans.On a year-over-year basis, the $366 million growth was also driven by the same loan categories and solid increases across all loan types. Asset quality improved significantly with nonperforming loans decreasing to $1.3 million or 2 basis points of total assets. Total deposits remained flat on sequential quarter and a year-over-year basis. However, core deposits increased by $39 million from the previous quarter and by $103 million from a year ago.Our loan-to-deposit ratio was at 85% as of the end of the second quarter. Competition for deposit gathering in our market remains sharp, and we continue to focus on building our core deposit base with strong customer relationships and service delivery. A very successful consumer Exceptional Checking account campaign was executed in the second quarter, and we continue to expand our small business markets with strong market presence.At this time, I'll turn the call over to David to review in more detail the highlights of our financial performance. David?

Thank you, Catherine. Net income for the second quarter of 2019 was $13.5 million or $0.47 per diluted share compared to net income of $16.0 million or $0.55 per diluted share reported last quarter. The first quarter 2019 results included a $2.6 million pretax gain on sale of MasterCard stock. Return of average assets in the second quarter was 0.92%, and return on average equity was 10.73%.Net interest income increased $0.3 million to $45.4 million on a sequential quarter basis and net interest margin was relatively stable at 3.33%. During the second quarter, we recorded a provision for loan and lease losses of $1.4 million compared to a provision of $1.3 million recorded in the prior quarter.Net charge-offs in the second quarter totaled $0.4 million compared to net charge-offs of $1.9 million in the prior quarter. At June 30, our allowance for loan and lease losses was $48.3 million or 1.14% of outstanding loans and leases. Second quarter other operating income totaled $10.1 million compared to $11.7 million in the prior quarter. The decrease was primarily due to a gain on sale of MasterCard stock in the prior quarter, partially offset by higher income from our Investment Services business of $0.5 million.Other operating expense for the second quarter was $36.1 million compared to $34.3 million in the prior quarter. The sequential quarter increase was primarily driven by higher salaries and employee benefits of $0.7 million and higher promotions expense of $0.8 million. The increase in salaries and benefits was partially RISE related and the increase in promotions expense was due to the previously mentioned core deposit campaign. The efficiency ratio for the second quarter was 65.1% and reflects the RISE-related investments as well as the core deposit promotion expense. The effective tax rate was 24.7% in the second quarter. Going forward, we expect the effective tax rate to be approximately 24% to 26%.We announced in June 2019 that the Board authorized a new share repurchase plan with authorization up to $30 million. During the second quarter of 2019, we repurchased approximately 214,000 shares of common stock at an average cost per share of $29.22.Thanks, and now I'll return the call to Paul.

Thank you, David. Overall, we are pleased with the continued growth and profitability of our company, while improving asset quality and maintaining a strong capital position. The timing is right to embark on RISE2020, to invest in meeting the changing needs of our markets and for the long-term viability of our franchise. We believe this acceleration of our growth strategy will generate an improved and sustainable financial performance for the benefit of all of our stakeholders. On behalf of our management team, I'd like to thank our employees, customers and shareholders for their continued support and confidence in our organization as we work toward reaching higher levels in the coming years.At this time, we'll be happy to address any questions you may have. Thank you.

[Operator Instructions]. Our first question comes from Aaron Deer of Sandler O'Neill + Partners.

I missed just the first few minutes of the call. So forgive me if I ask something that's been addressed. But just digging into the RISE2020 initiatives, can you talk about what specifically, I guess, is different from this versus some of the other technology and efficiency initiatives that you've been taking for the past few years? And it seems like some of this is more -- has the expectation of driving revenues hard. Can you talk specifically about how that is expected to play out?

Sure. Thanks, Aaron. This is Paul Yonamine. I think I'd like to touch on a couple things on our overall RISE2020 initiative. And the first area, everyone is talking about digital banking today. And I think the way the market is, at the end of the day, over a period of time, many banks are going to be pretty much on a similar platform in the digital banking technology, but I think some of us have an opportunity to advance a lot quicker. And one of the major initiatives in our RISE2020 plan is to migrate to a best-in-class online and mobile banking platform that, I think, is going to be very unique for this marketplace.Our bank is making a big leap in utilizing cloud technologies. I believe that we'll be taking a hard look at data analytics, artificial intelligence at a level that I feel will differentiate from what other financial institutions are doing, even in the U.S. mainland. So this is going to be one area, a lot of the investment associated with it, it's on a software-as-a-service basis, so it's not baked in completely into the $40 million. These are things that we incur on a year-to-year basis, right? But we think that's going to be a key strength within our RISE2020 investment.Another area, even on our facility's investment in downtown Honolulu, this is a unique dynamics for Hawaii. Our building is positioned in a really critical location in downtown Honolulu and a lot of what we do with the facility is going to turn into a huge billboard that really creates and supports more relevance for the bank at least in this marketplace.A third area that, again, I think, as part of our RISE2020 that we've been spending a lot of time, and this relates to digital strategy is that we are, as an organization, making a real investment on process reengineering and also on how we operate the business. We've already started this in the second quarter, and a lot of it is some of the underpinnings on our growth for loan growth and deposit growth during the second quarter.

Okay. That's helpful. I appreciate that. And I guess just since these investments are presumably going to be ramping up over the next 12, 18 months, I know you've given your long-term objectives in terms of where you'd like to get the efficiency down to, but over the next 12 to 18 months, as this ramps, can you maybe give us a sense of where the noninterest expenses might go on a dollar basis and also maybe on an efficiency basis? Because it -- my expectation is we're probably going to be trending up toward $39 million, $40 million on a quarterly basis, but just would like to get your thoughts on that?

Thanks, Aaron. I'm going to have David Morimoto to that. David?

Thanks, Paul. Aaron, so other operating expense in the second half of 2019, we're guiding to a $34 million to $36 million range. So it's similar to what we saw in the second quarter. But as Catherine mentioned, there was a core deposit campaign in the second quarter that will not recur in the back half of 2019. So we're estimating roughly $2.5 million of RISE-related expense in the second half, so it is very similar to what was in the second quarter results. So $34 million to $36 million in the back half of '19 -- quarterly in the back half of '19 and then we expect that to rise to $36 million to $38 million in 2020. How it ramps up to the $36 million to $38 million will be dependent on our implementation of various initiatives. So it'll take place over time. But by the end of 2020, we'll be in the $36 million to $38 million range.

Okay. That's helpful. And maybe another one for you on the -- just your margin. Given obviously the rate environment has been changing pretty quickly this year in terms of the outlook and expectations for the Fed. Given kind of what's expected out of the Fed at this point and some of the different dynamics affecting your margin, including some of your securities purchases, and I guess that book has been down, but maybe you start building that from here, what's your expectation for the margin through the back half of this year?

Yes, Aaron, we're maintaining our net interest margin guidance at 3.25% to 3.35% and that's assuming two Fed ease-ins in the back half of '19 and 1 in the first half of 2020. As we've discussed over many quarters, the balance sheet is relatively well matched. So that's why we didn't see a significant pickup in the margin in the rising rate cycle. Similarly, we don't expect a lot of degradation of the net interest margin to the extent that rates reverse course. So we're sticking with the 3.25% to 3.35% guidance.

Our next question comes from Luke Wooten of KBW.

Just kind of wanted to keep it going on that margin, just -- so that 3.25% to 3.35%, is that through the end of this year? And in next year, is it kind of just going forward without really a time line associated with it? I know you put to the two Fed cuts at the end of this year and then one in the first half of next year. I just wanted to see like if we're looking at 4Q '20, I know it's obviously a lot of moving parts in there, just kind of relatively down from here or is it well matched in that 3.25% to 3.30% guidance?

Yes, Luke, this is David. I think definitely 3.25%, 3.35% for the next 2, 3 quarters. End of 2020, we would hope that we could be seeing some expansion, but the big wild card will be the yield curve, the steepness of the yield curve. But for the next several quarters, we're comfortable with the 3.25% to 3.35%.

Okay. That's helpful. And then just going back to the RISE2020, just what kind of revenue synergies? What should we see the timing with that? I know that there is -- some of the stuff is coming on with the commercial end-to-end and other technology efficiencies, just kind of wanted to see how we should look at fee income lines as well as kind of in the net interest income embedded in that number just through kind of different platforms you guys are working in?

Sure. Luke, this is Paul Yonamine. So naturally, we need a period of time to make a lot of these investments. But operationally, we've already commenced in Q2 in terms of revenue enhancements, revenue generation. We have done some reorganization on our customer-facing organization. We have new leaders appointed within the organization. There is more of an operational discipline and a cadence in terms of loan pipeline management, in terms of frequency of customer visitations. We are getting very granular on how we go to market today. And because we understand with these investments, we have to deliver even now. And so this has -- we have embarked on this process in full force in Q2, and we anticipate that, that will be a tremendous trigger on some of our loan and deposit growth in the quarters ahead.

Okay. That's super helpful. Just kind of switching over to the portfolio growth. You guys saw really strong loan growth this quarter, and just wanted to see how the full year guide of mid-single digit is coming in? Is that going to be in the higher end of that or do you see it softening a little bit in the back end -- or back half of 2019?

I'll have Catherine respond to that. Catherine?

Sure. Yes, we were really pleased to see that $145 million loan growth number for Q2. Paul spoke to the sales discipline that we've employed here in the organization at much a higher level. So we are updating our guidance for loan growth for the back half of the year and now with -- we'll say it will be mid-to-high single digit.

Okay. That's helpful. And then just finally, just kind of wanted to see, with the new expenses kind of getting pushed into the RISE2020, should we see that kind of impact repurchases going forward? Just how should we think about that, especially with the reauthorization at the end of June?

Luke, it's David. Yes, we will continue the share -- the open market share repurchase program. But as we started mentioning earlier this year, the pace of repurchases may slow, but obviously that will be market driven. We're the ultimate insider and if depending on market changes, we can increase or decrease the volume. But there will continue to be an open market share repurchase program.

Our next question comes from Laurie Hunsicker of Compass Point.

Paul, I just wondered if you could go back to some of the comments you made around RISE2020 and the potential to capture business in Japan. Can you help us think about that?

Sure, I'd be happy to do that, Laurie. So from last year, we effected alliances with seven Japanese regional banks. And naturally, through these type of relationships with Japanese organizations, it sometimes takes time to cultivate a lot of the customer referral. So we're starting to see a steady stream of that. As many of you know, Japan is going through a tremendous economic cycle today. Corporations, individuals are extremely cash rich, and we feel that one of our key focus is, given the interest of Japanese investors and tourists in the state of Hawaii, that we need to do a better job harvesting those opportunities. So again, it takes a little time, but I think we are showing good signs of development. I'll be going to Japan next week as well with a very loaded itinerary, but that's going to be one of our key areas of focus and trying to work with our alliance partners, visiting a lot of customer prospects as well, Laurie.

And so I guess -- and I don't know this, so forgive me if you chatted about it before and I missed it, but of your $4.2 billion or so loan book, how much of that is to customers in Japan?

So the loans themselves -- I think our focus is primarily around deposits with the Japanese investor or customer base. In terms of loans, we'll see some lift as they continue to have interest investing in residences here in Hawaii, and we've been seeing a lot of activity, especially on the high-end on residential purchases. The Japanese have not been that active in the Hawaii market in terms of overall commercial or large-scale residential developments yet. Our focus has been more with the consumer.

Got it. Okay. And then I guess, same question on the $5 billion in deposits, how much of that is coming from Japanese investors?

I don't have that number with me right now. David, do you have that number?

Yes. It's in excess of $0.5 billion.

Okay. And then how -- I mean, how are you thinking about in terms of growing?

Right. So there are a couple avenues there. One thing, given the robustness of the Japanese economy today, we are actively talking to our alliance partners about having a better view of providing consulting and counseling services to their clients and trying to hedge the yen a little bit more by having a bigger dollar presence in their portfolio. That's number one. The second thing is that we're looking at certain niche opportunities, for example, like, captive insurance. Hawaii and Vermont are the two states that have the most progressive captive insurance regulations in the nation. And we feel that Japanese companies are really way behind the bar in terms of self-insurance and creating captive insurance companies. And that's been a very good angle for us, and we plan to continue pursuing that.

Okay. Great. And then David maybe can you just -- going back to the RISE2020 expenses, I want to make sure I'm thinking about this the right way. So in the $36 million of total noninterest expense, it included $1 million of the RISE. When we look at your guide of $2.5 million for the back half, let's call it, $1.25 million spread equally between third and fourth quarter hypothetically, is that $1.25 million going to be in addition to the $1 million as a $1 million of run rate? Or is it your spending $1 million in June and then that jumps up $250,000 give or take in September? How should we be thinking about that?

Yes, Laurie, it's more the latter. So it's the $0.25 million increment in the back half.

Perfect. Okay. And just to clarify and Catherine you mentioned this, entertainment and promotions, the $1.023 million and I know that was very outsized, where should that number be running?

Yes. That figure, the $1 million includes about $800,000 in the promotional expense, which is nonrecurring. And it was in connection with the Exceptional Deposit account campaign. So if you back that out, that is about where you should expect to see it other in instances where we might have a special campaign.

Okay. That's great. That's helpful. Okay. And then last thing on the RISE2020, how should we think about this in terms of a delta in terms of changing your loan growth or changing your deposit growth or changing your fee income? How does this play through?

Yes. Thanks, Laurie. I think RISE2020 is basically also a call to action for all of our frontline bank employees, whether it be at branches or officers. They all have a playbook and starting today that they start going out to the market. Central Pacific Bank, this is our 65th year in the state of Hawaii. We've done a lot for the community. RISE2020, especially our main building here, we'll be creating a community area that a lot of our customers and nonprofit organizations can utilize. And our employees believe that this is a tremendous opportunity for us to go out to the market, remind a lot of our customers about the history that our bank has had with them and ask them in turn to double down on their business with us. I think our employees are committed. We have an operational system to support that. And we're quite excited and looking forward to what happens in the weeks and months ahead.

[Operator Instructions]. Our next question comes from Don Worthington of Raymond James.

Just a couple of questions in terms of maybe going back to the core deposit campaign. Can you size the success of that in terms of what you're able to raise from the special campaign?

Yes, sure. We were really pleased with the results of this campaign, so the lift within the $30 million to $40 million range. And for us, we've talked about this in previous calls, the importance of that lift is these are relationships with customers that we believe will eventually need other products and services from our organization. This account has a required minimum dollar balance. So for us, it's much about the opportunity that, that lift represents as it is about the actual amount into the deposit number.

Okay. Great. And then FHLB advances were up in the quarter. Was that kind of a temporary funding of the loan growth until deposit growth catches up?

Don, it's David. That's correct. So as you saw, loan growth outpaced deposit growth in the quarter. We did -- we were able to reduce the investment portfolio some, but the remainder was funded with FHLB advances. And as you know, we've been going back and forth between FHLB advances and public government CDs and it's really a function of pricing. Whichever is cheaper is where we will do the excess funding from.

Okay. And then were there any loan purchases this quarter?

Let me take that question, Don. There was a loan purchase in the $30 million range, and it was to follow on what we reported last quarter, a profitable purchase. This is on top of a purchase we made in Q1.

Okay. So that shows up in the mainland loans?

It shows up in mainland consumer, that's right.

This concludes our question-and-answer session. I would like to turn the conference back over to Paul Yonamine for any closing remarks.

Yes, that's Paul Yonamine. Everyone, really thank you very much for participating in our earnings call for the second quarter of 2019. We look forward to future opportunities to update you on our progress. Many thanks.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.